U.S., Europe Have No Excuse for Next Recession
Four years after the onset of the Great Recession, a second and possibly worse global slump is starting to seem possible. If this happens, governments won’t be able to say they were taken by surprise. It will happen because governments have frozen in the face of hazards that are well understood and readily avoidable.
It’s hard to say whether the policy paralysis is worse in Europe or the United States. I give the edge to Europe, where the failure of leadership has been more thorough and sustained. Still, the difficulties in the U.S. are easier to overcome, so neglecting them is more boldly incompetent. The country’s politicians, busy campaigning, have effectively said they’ll get back to us, maybe, after November’s elections. That’s audacious.
It has been plain for months, if not years, that the European Union needs collective monetary stimulus and some measure of debt mutualization to stabilize its economies. You would think neither would pose much of a test for an association of nations dedicated by treaty to “ever closer union.” Yet trying to avoid these steps has inflicted shattering recessions on several EU countries and worsened a manageable crisis of confidence to the point where it might destroy the entire euro project.
Europe’s central bank has been flexible in providing liquidity to the euro area’s banks, but in setting interest rates it continues to worry more about the distant threat of inflation and arcane constitutional proprieties than collapsing output and employment. On explicit debt mutualization, the EU has so far done nothing. Germany and others have opposed the crucial step of issuing jointly guaranteed euro bonds.
The only flicker of hope comes in a German plan that would allow governments to issue a limited amount of mutually backed debt for a limited period. It’s not very good, and couldn’t be executed quickly. German Chancellor Angela Merkel isn’t backing it, you understand, but she has stopped vowing it will never happen. Hence the excitement.
First proposed in November, the so-called European Redemption Pact would pool each euro area member’s debts in excess of 60 percent of gross domestic product in a jointly guaranteed fund. Countries would promise not to increase the remaining, national part of their debt above the 60 percent ceiling. Access to the redemption fund would let Spain and other distressed borrowers refinance their excess borrowing at lower interest rates, and would lift the fear of default. Strong creditors, such as Germany, would also pool some of their debt according to the same rules. They’d have to pay a bit more than it would cost them to refinance unilaterally. That’s the subsidy element that Merkel has hitherto ruled out.
The plan has two main differences from the “conditional euro bond” proposal I wrote about last week. First, it’s meant to be temporary, an aspect that Merkel is stressing. The fund would be paid down over 20 to 25 years, using tax revenue pledged in advance from the countries whose debts had been pooled. Once the debt was paid off, the EU would be back to national fiscal sovereignty, plus the budget and debt constraints in the Stability and Growth Pact that was adopted as part of the original euro design. In other words, it would be back to the arrangement that let Europe get into this mess in the first place.
The second difference is that, unlike conditional euro bonds (which involve side payments from less creditworthy to more creditworthy countries), the redemption pact includes no market incentives for compliance and no room to maneuver. The emphasis is on compulsion: Participants must give up tax revenue, post gold or foreign reserves as collateral, and suffer severe sanctions if they fail to make their payments or let their national debt rise back above 60 percent. To comply, countries such as Italy would have to practice extreme austerity under threat of reprisal for many years.
Worse, the plan would mean prolonged delay and uncertainty. It requires a new EU treaty, which would then have to be ratified nation by nation. And in the end, when this system confronted a crisis like today’s, it would fold - just as the original Stability and Growth Pact folded - because meeting its terms would be politically impossible.
The only good thing about the new plan is that it suggests Merkel might eventually be willing to think the unthinkable, and actually do something. By EU standards, that’s progress.
If the U.S. has shown greater flexibility in dealing with its crisis, the credit goes mostly to the Federal Reserve. Granted, the central bank’s freedom of action in the crisis is a constitutional anomaly. The Fed’s enormous programs of quantitative easing are fiscal policy as much as monetary policy and therefore, you might argue, properly the domain of Congress. Luckily, that interpretation is not, for now at least, being pressed.
Since the fiscal stimulus passed in 2009, Washington has been more or less paralyzed. The Fed has exploited a freedom that Europe’s central bankers believe they lack, and has been the only part of the U.S. government executing an intelligible economic policy.
Last week’s dismal employment figures, together with downward revisions for growth in the first quarter, point to another pause in the U.S. recovery and turn attention to the Fed again. The case for a further round of the bond-buying known as quantitative easing seems overwhelming. And more QE, apparently, is all there is, because the rest of Washington is otherwise engaged. With luck, the Fed will act.
The U.S. economy’s needs are just as obvious and feasible as those of Europe. On fiscal policy, the prescription is unchanged: Congress needs to combine budgetary ease in the short run with a credible commitment to reduce debt in the long run. Neither is any use without the other. The blueprint for this exists in the Simpson-Bowles plan. It’s astonishing, or should be, that nobody in Washington - not Democratic President Barack Obama, not Republican candidate Mitt Romney, nobody in Congress and nobody running for Congress - thinks that this or any other detailed plan of action is worth discussing.
What’s even more depressing is that the country doesn’t seem to mind. This must be because this election is about bigger issues. It’s about the future of capitalism and the role of the state. It’s about liberty, the Constitution, social solidarity and American exceptionalism. Politicians and activists aim to keep fighting about those subjects until November. Then they’ll discover that nothing has been settled, so they’ll keep on fighting to resolve them, once and for all, in some election after that.
Voters mustn’t expect the impossible. In Europe, nothing can be done until Germany’s leaders have worked out what “political union without fiscal union” might mean. As for the U.S., between now and the next crash, there’s just no time in the schedule to fix the economy.
Clive Crook is a Bloomberg View columnist.